Groundhog Day

Crowds gather early in the morning to watch for what the future will bring.

The media is on hand for the latest predictions and they run stories with sensational headlines to engage their audience.

Men in coat and tie confer, hoist prominent prognosticators on high and loudly sing praises about their ability to predict the future.

Beyond the Punxsutawney Phil ceremony illustrated in the picture above, what was I just describing on this Groundhog Day?

Wall Street and the endless daily stream of chatter about morning futures and estimates about the direction of the financial markets.

Unfortunately, research suggests that the wizards of Wall Street often have about as much predictive power as the Wizard of Oz and as much success in predicting the future as groundhogs.

Just as it is might be hard to resist clicking on stories about Punxsutawney Phil and his predictions of Spring, it is hard to not get caught up in the emotion and allure of economic and market predictions.

As Patrick O’Shaughnessy recently wrote in his blog, The Investor’s Field Guide, “our brains evolved to recognize patterns, which creates the side effect that we are pattern junkies.” As he writes, “this pattern-addiction makes us obsessed with the future”, which is only “enhanced by the psychological bias known as the halo effect. The better known, more intelligent, better looking, or more respected an expert forecaster is, the greater the confidence we have in their predictions.”

As I have written about before, even Federal Reserve Governors and their economists are poor soothsayers (see the bottom of this article for related posts and research).

Below is a quote from a report published in February of 2015 by the Federal Reserve Bank of San Francisco based on a study of the Federal Reserve Open Market Committee’s Summary of Economic Projections (SEP):

“Over the past seven years, many growth forecasts, including the SEP’s…, have been too optimistic. In particular, the SEP forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently over-predicted the speed of the recovery that started in June 2009.”

Some might say, “well, this not unexpected, the best minds are not in the public sector but in the private sector inside the best investment banks.”

My halo bias wants to believe this, but independent analysis of investment analysts’ estimates and projections paints a consistent picture.  They are also often wrong at the wrong time.

As an example, McKinsey & Company produced a study in 2001 about the accuracy of earnings estimates, which was then updated in 2010.  The following quote summarizes their findings:

“Analysts, we found, were typically overoptimistic, slow to revise their forecasts to reflect new economic conditions, and prone to making increasingly inaccurate forecasts when economic growth declined.  On average, analysts’ forecasts have been almost 100 percent too high.”

The chart below is from the most recent 2010 McKinsey & Co. research paper. The light green line represents Wall Street earnings forecasts. The blue line reflects what actually happened.

Capture 3

Like Bill Murray could not believe during his groundhog day experience, surely we learned something during the last financial crisis and are not repeating things over and over the same way.

Well, just as recent experience has shown that political predictions are difficult, research on the accuracy of investment estimates continues to disappoint.

CXO Advisory recently published a report based on over 6,500 predictions made by 68 investment gurus covering the time period 1998 – 2012.

What did they find?

The accuracy of well-known investment strategy professionals, to include Jeremy Grantham and Abby Joseph Cohen, was only 47%, or worse than a coin toss (see the following for the complete study – Guru Grades).

Evidence suggests that market predictions aren’t worth much, but this doesn’t mean you should go into an investment hole during difficult, wintry market conditions.

If you have spent time developing a long-term plan that is based on your goals, and not the models of others, stay on course, or as we wrote about before, just Keep A Steady Hand On The Tiller.

So, if you see rough market shadows that make you feel like a groundhog, remember, history shows that market troubles eventually thaw, and that steady long-term investors are consistently rewarded.

And hey, if you want confirmation that I am correct, just read the stories out today about Punxsutawney Phil. He did not see his shadow, so the good times of Spring are definitely just a few weeks away.

 

More of Preston’s posts and research related to this article can be found at the following links:

Equity Analysts: Still Too Bullish – McKinsey Quarterly - April 2010

Prophets and Profits – McKinsey Quarterly – October 2001

If We Had A Chief Economist We Would Have To Pay Them – April 2015

Don’t Be A Sheep – May 2015

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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